Dangerously high debt levels are keeping Ireland vulnerable

Debt sustainability for individuals, companies and countries is a very important concept. It seeks to determine the appropriate or manageable level of debt measured, in terms of servicing costs and the vulnerability that debt creates in the event of some shock to the system.

For example, back in 2010, Ireland had built up such a high level of debt as a result of the collapse in the public finances and the investment in the banking system, international investors lost confidence in the ability of the Irish State to service and repay that debt.

Irish bond yields shot up and - more importantly - international investors became very reluctant to loan money to the country at affordable rates of interest. Too much debt creates a very dangerous vulnerability whatever way one looks at it.

In the qualification process for European Economic and Monetary Union (EMU) in the 1990s, a Government debt to GDP ratio of 60% was deemed the highest acceptable level of debt. There was nothing terribly significant or scientific about that target, but it was deemed by those in the know to be sustainable from a debt servicing cost perspective.

That level of debt was deemed to be sustainable back then when bond yields were much higher and debt servicing costs much more expensive than they are today. With the Irish Government now in a position to borrow at virtually no interest cost, it is probably the case that the sustainable level of debt for Ireland is now closer to 80%.

In the event, at the end of 2018, Ireland had a debt-to-GDP ratio of around 64%, which as well as being extremely sustainable, is one of the lowest debt levels in the EU.

However, looks can be deceiving. As most people now fully understand, GDP is a hopelessly inadequate metric for Ireland, given the extent to which it is inflated by factors such as aircraft leasing and the transfer of intellectual property assets to the balance sheets of multinationals based in Ireland.

Gross National Income* (GNI*) is deemed by the CSO as a more appropriate metric for measuring the Irish economy, as it seeks to strip out those balance sheet and other artificial distortions. GNI* is significantly lower than GDP and so if we measure Government debt as a percentage of that lower growth metric, the debt level jumps to 104%.

The bottom line is that Ireland still has a dangerously high level of debt and a Central Bank economic letter earlier this week focused on the vulnerability created by that debt in the event of a sharp fall in corporation tax receipts or a hard Brexit.

The problem, of course, is that it is far from clear at the moment what Government can do about that. The option of increasing taxes is not politically doable, and indeed that is being hammered home at the moment by the ludicrous decision by some local councils to cut property taxes.

On the other hand, it is not clear where Government could possibly cut expenditure, given the very stretched nature of public services such as health, law and order and particularly education. Hopefully, we can just keep growth going and bring down the burden of debt by cyclical rather than structural means.

Following the further amazing developments in the Brexit circus this week, it is still not clear if or when a hard Brexit might happen. With Parliament resuming, it is unlikely that Boris Johnson will agree a deal with the EU by October 19, and so he may be forced to seek an extension from the EU.

That would likely result in a UK general election before the end of the year, and it is far from clear that the barmy Labour Party - at least the leadership - would be capable of winning that election.

If Boris Johnson is still leader, he would be likely to take a very populist stance and argue that he would deliver the Brexit that the people voted for in the face of opposition from the elites such as the intelligentsia in London or the 11 supreme court judges.

That approach works for Donald Trump, so why not for Boris? That stance might just work for Mr Johnson. Following this week’s events, one might conclude that a hard Brexit has been postponed, but is still very much on the agenda, unless a deal can be agreed between the EU and the UK.